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tv   Key Capitol Hill Hearings  CSPAN  April 1, 2014 8:00pm-10:01pm EDT

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smelled it and heard the whistles and known right away that you were in the middle of timber town, usa. ..
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the president: everybody, please have a seat. thank you so much. welcome to the white house. six months ago today, a big part of the affordable care act kicked in as and state insurance marketplaces went live. and millions of americans finally had the same chance to buy quality, affordable health care -- and the peace of mind that comes with it -- as everybody else. last night, the first open-enrollment period under this law came to an end.
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and despite several lost weeks out of the gate because of problems with the website, 7.1 million americans have now signed up for private insurance plans through these marketplaces -- 7.1. (applause.) the truth is, even more folks want to sign up. so anybody who so anybody who was stuck in line because of the huge surge in demand over the past few days can still go back and finish your enrollment -- 7.1 million, that's on top of the more than 3
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million young adults who have gained insurance under this law by staying on their family's plan. that's on top of the millions more who have gained access through medicaid expansion and the children's health insurance program. making affordable coverage available to all americans, including those with preexisting conditions, is now an important goal of this law. (applause.) and in these first six months, we've taken a big step forward. and just as importantly, this law is bringing greater security to americans who already have coverage. because of the affordable care act, 100 million americans have gained free preventive care, like mammograms and contraceptive care, under their
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(applause.) because of this law, nearly 8 million seniors have saved almost $10 billion on their medicine because we've closed a gaping hole in medicare's prescription drug plan. we're closing the donut hole. we're closing the donut hole. (applause.) and because of this law, a whole lot of families won't be driven into bankruptcy by a serious illness, because the affordable care act prevents your insurer from placing dollar limits on the coverage they provide. these are all benefits that have been taking place for a whole lot of families out there, many who don't realize that they've received these benefits. but the bottom line is this: under this law, the share of americans with insurance is up and the growth of health care costs is down, and that's good for our middle class and that's good for
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our fiscal future. (applause.) now, that doesn't mean that all the problems in health care have been solved forever. premiums are still rising for families who have insurance, whether you get it through your employer or you buy it on your own -- that's been true every year for decades. but, so far, those premiums have risen more slowly since the affordable care act passed than at any time in the past 50 years. it's also true that, despite this law, millions of americans remain uncovered in part because governors in some states for political reasons have deliberately refused to expand coverage under this law. but we're going to work on that. and we'll work to get more americans covered with each passing year.
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(applause.) (applause.) and while it remains true that you'll still have to change your coverage if you graduate from college or turn 26 years old or move or switch jobs, or have a child -- just like you did before the affordable care act was passed -- you can now go to and use it year-round to enroll when circumstances in your life change. so, no, the affordable care act hasn't completely fixed our long-broken health care system, but this law has made our health care system a lot better -- a lot better. (applause.) all told, because of this law, millions of our fellow citizens know the economic security of health insurance who didn't just a few years ago -- and that's
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something to be proud of. regardless of your politics or your feelings about me, or your feelings about this law, that's something that's good for our economy, and it's good for our country. and there's no good reason to go back. let me give you a sense of what this change has meant for millions of our fellow americans. i'll just give you a few examples. sean casey, from solana beach, california, always made sure to cover his family on the private market. but preexisting medical conditions meant his annual tab was over $30,000. the affordable care act changed that. see, if you have a preexisting condition, like being a cancer survivor, or if you suffer chronic pain from a tough job, or even if you've just been charged more for being a woman -- you can no longer be charged more than anybody else. so this year, the casey family's premiums will fall from over $30,000 to under $9,000.
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(applause.) and i know this because sean took the time to write me a letter. "these savings," he said, "will almost offset the cost of our daughter's first year in college. i'm a big believer in this legislation, and it has removed a lot of complexity and, frankly, fear from my life. please keep fighting for the aca." that's what sean had to say. jeanne goe is a bartender from enola, pennsylvania. now, i think most folks are aware being a bartender, that's a job that usually doesn't offer health care. for years, jeanne went uninsured or underinsured, often getting some health care through her local planned parenthood. in november, she bought a plan on the marketplace.
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in january, an illness sent her to the hospital. and because her new plan covered a cat scan she wouldn't have otherwise been able to afford, her doctor discovered that she also had ovarian cancer -- and gave her a chance to beat it. so she wrote me a letter, too. she said it's going to be "a long tough road to kill this cancer, but i can walk that road knowing insurance isn't an issue. i won't be refused care. i hope to send a follow-up letter in a few months saying i am free and clear of this disease, but until then, i know i will be fighting just as you have been fighting for my life as a working american citizen." and after her first wellness
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visit under her new insurance plan, marla morine, from fort collins, colorado, shared with me what it meant to her. "after using my new insurance for the first time, you probably heard my sigh of relief from the white house." (laughter.) "i felt like a human being again. i felt that i had value." that's what the affordable care act, or obamacare, is all about -- making sure that all of us, and all our fellow citizens, can count on the security of health care when we get sick; that the work and dignity of every person is acknowledged and affirmed. the newly insured like marla deserve that dignity. working americans like jeanne deserve that economic security. women, the sick, survivors -- they deserve fair treatment in
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our health care system, all of which makes the constant politics around this law so troubling. like every major piece of legislation -- from social security to medicare -- the law is not perfect. we've had to make adjustments along the way, and the implementation -- especially with the website -- has had its share of problems. we know something about that. and, yes, at times this reform has been contentious and confusing, and obviously it's had its share of critics. that's part of what change looks like in a democracy. change is hard. fixing what's broken is hard. overcoming skepticism and fear of something new is hard. a lot of times folks would prefer the devil they know to the devil they don't. but this law is doing what it's supposed to do. it's working.
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it's helping people from coast to coast, all of which makes the lengths to which critics have gone to scare people or undermine the law, or try to repeal the law without offering any plausible alternative so hard to understand. i've got to admit, i don't get it. why are folks working so hard for people not to have health insurance? why are they so mad about the idea of folks having health insurance? many of the tall tales that have been told about this law have been debunked. there are still no death panels. (laughter.) armageddon has not arrived. instead, this law is helping millions of americans, and in the coming years it will help millions more.
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i've said before, i will always work with anyone who is willing to make this law work even better. but the debate over repealing this law is over. the affordable care act is here to stay. (applause.) and those who have based their entire political agenda on repealing it have to explain to the country why jeanne should go
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back to being uninsured. they should explain why sean and his family should go back to paying thousands and thousands of dollars more. they've got to explain why marla doesn't deserve to feel like she's got value. they have to explain why we should go back to the days when seniors paid more for their prescriptions or women had to pay more than men for coverage, back to the days when americans with preexisting conditions were out of luck -- they could routinely be denied the economic security of health insurance -- because that's exactly what would happen if we repeal this law. millions of people who now have health insurance would not have it. seniors who have gotten discounts on their prescription drugs would have to pay more. young people who were on their parents' plan would suddenly not have health insurance. in the end, history is not kind to those who would deny americans their basic economic
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security. nobody remembers well those who stand in the way of america's progress or our people. and that's what the affordable care act represents. as messy as it's been sometimes, as contentious as it's been sometimes, it is progress. it is making sure that we are not the only advanced country on earth that doesn't make sure everybody has basic health care. (applause.) and that's thanks in part to leaders like nancy pelosi and dick durbin, and all the members of congress who are here today. we could not have done it without them, and they should be proud of what they've done. they should be proud of what they've done. (applause.) and it's also thanks to the often-unheralded work of countless americans who fought
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tirelessly to pass this law, and who organized like crazy these past few months to help their fellow citizens just get the information they needed to get covered. that's why we're here today. that's why 7.1 million folks have health insurance -- because people got the word out. and we didn't make a hard sell. we didn't have billions of dollars of commercials like some critics did. but what we said was, look for yourself, see if it's good for your family. and a whole lot of people decided it was. so i want to thank everybody who
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worked so hard to make sure that we arrived at this point today. i want to make sure everybody understands: in the months, years ahead, i guarantee you there will be additional challenges to implementing this law. there will be days when the website stumbles -- i guarantee it. so, press, just -- i want you to anticipate -- (laughter) -- there will be some moment when the website is down -- and i know it will be on all of your front pages. it's going to happen. it won't be news. there will be parts of the law that will still need to be improved. and if we can stop refighting old political battles that keep us gridlocked, then we could actually make the law work even better for everybody. and we're excited about the prospect of doing that. we are game to do it. (applause.)
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but today should remind us that the goal we set for ourselves -- that no american should go without the health care that they need; that no family should be bankrupt because somebody in that family gets sick, because no parent should have to be worried about whether they can afford treatment because they're worried that they don't want to have to burden their children; the idea that everybody in this country can get decent health care -- that goal is achievable. we are on our way. and if all of us have the courage and the wisdom to keep working not against one another, not to scare each other, but for one another -- then we won't just make progress on health care. we'll make progress on all the other work that remains to create new opportunity for everybody who works for it, and to make sure that this country that we love lives up to its
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highest ideals. that's what today is about. that's what all the days that come as long as i'm president are going to be about. that's what we're going to be working towards. thank you very much, everybody. god bless you. god bless america. (applause.) thank you. [ applause ] >> on the next washington journal, our guest are tim grisen, a member of the house and means committee. we will focus on ukraine with senator ben cardon, the maryland
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democrat is a member of the foreign relation committee. and abigail joins us to talk about the rising amount of alzheimer's cases. bend is a timber town. you would not know it looking at it today. the qualities are removed but it was a timber town to begin with. at the height of the timber industry, if you dropped into bend in say, 1928, you would have smelled the mills and sawdust. if you went through certain
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parts of town you would get the saw dust on your closes and you would hear the whistles and it would have been part of everything. it would have been ten minutes off from the downtown core but ul you would have seen the smoke, heard the whistles and known you were in the middle of timber town u.s. >> we look at the history of bend, oregon on saturday. >> today, a senate hearing looked at the taxed paid by manufacture company caterpillar. they have shifted profits to
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switzerland to avoid taxes. >> good morning, everybody. the subcommittee for many years has investigated how some of our most profitable corporations exploit loopholes in the u.s. tax code to shift income and profits to offshore tax havens, thereby denying tax revenue to uncle sam. corporate income tax revenue accounts for a smaller and smaller share of federal receipts, and today is down to about 10% of federal revenue, despite the fact that corporate profits are at an all-time high. tax avoidance through the use of dubious tax loopholes costs the treasury tens of billions each year, making it harder for us to invest in the education, innovation and infrastructure that promote our prosperity, and to adequately fund our national security, while at the same time increasing the tax burden
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on families and businesses who can't employ an army of tax lawyers. the subject of our report and of today's hearing is caterpillar inc. caterpillar is an american success story that produces iconic industrial machines. we will examine caterpillar's tax strategy at today's hearing. but first i want to thank caterpillar and its accounting firm, pricewaterhousecoopers (pwc), for their cooperation with the subcommittee. headquartered in peoria, illinois, caterpillar designs and builds a wide range of heavy construction equipment, power generators, and engines, assembling most of them here in the united states. on worksites around the world,
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its bright yellow machines are symbols of u.s. manufacturing excellence. its revenues exceeded $120 billion over the last two years. in addition to manufacturing machines, caterpillar operates a lucrative replacement parts business, selling caterpillar-branded parts to customers around the world. it is this aspect of their business, specifically its foreign sales of replacement parts, on which this hearing will focus. caterpillar machines are known for their durability and dependability; they last literally for decades, a testament to their quality. to ensure their machines keep running well, caterpillar works to deliver needed parts anywhere in the world within 24 hours of an order. this commitment limits the amount of time a machine is out of service as well as extending its life.
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its parts operation helps the company maintain its reputation for building equipment that keeps working - a reputation that is key to its success. the parts operation is also highly profitable. in many years, the parts business accounts for a majority of caterpillar's profits despite making up just a fraction of sales. caterpillar maximizes its parts profits by designing machines that can be repaired and maintained only with caterpillar parts, ensuring decades of parts sales and profits. caterpillar branded parts are manufactured primarily by independent companies in the united states and shipped by caterpillar around the world. until 1999, caterpillar inc., or
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caterpillar u.s. taz created. despite this, they never took delivery or saw the parts it marketed. it served as the parts committee in africa, europe and inmiddle east acting as a liason helping the dealers and training. typically first passed title to marketing companies it had created, including one in switzerland called cosa. despite taking title, cosa never took physical delivery or even saw the parts it marketed. cosa served as caterpillar's marketing company and parts distributor in europe, africa, and the middle east, acting as a liaison between caterpillar u.s. and the foreign dealers, helping
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those dealers training, marketing campaigns, servicing issues, and parts inventory management. in exchange, cosa was allocated about 15% of the parts' foreign sales profits. until 1999, the vast majority of the remaining profits from those offshore sales, usually 85% or more, were included in caterpillar inc.'s u.s. strategy. strategy in place, it went from reporting about 85% or more of its foreign parts profits on its u.s. tax return to reporting 15% or less to uncle sam, and shifting the remaining profits offshore to its swiss affiliate. in switzerland, caterpillar d, caterpillar had negotiated a special effective swiss tax rate varying from 4% to 6% , which was below the swiss statutory tax rate of 8.5%. this strategy left the
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real-world operation of its parts business virtually unchanged; in fact, the only significant real-world impact of this arrangement was an instant major drop in caterpillar's u.s. caterpillar's u.s. tax bill. from 2000 to 2012, the swiss tax strategy shifted $8 billion in profits from caterpillar u.s. to its affiliate in switzerland. this cut caterpillar's u.s. tax bill by $2.4 billion during that period. the law says that transfer pricing agreements between related parties must have an economic substance - meaning a business
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purpose other than lowering taxes. but when one of caterpillar's key tax managers responsible for implementing the swiss tax strategy, rodney perkins, was asked, under oath, whether there was any business advantage to the swiss transaction other than the deferral or avoidance of corporate income taxes, he stated: "no, there was not. " though the lion's share of caterpillar's international parts profits shifted to its swiss affiliate, the heart and soul of caterpillar's parts business stayed right here in the united states. only a shadow of the parts business took place in switzerland. a few statistics showing the disparity are depicted on this chart. of caterpillar employees who handle parts, 4900 work in the
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united states; less than 100 work in switzerland. of the company's 125 manufacturing plants, 54 are in the united states; none are in switzerland. of the company's 19 parts warehouses, 10 are in the united states; none are in switzerland. today, there are 1.5 billion parts stored in caterpillar's u.s. warehouses; none are stored in switzerland. put another way, despite the fact that caterpillar now allocates only a small percentage of its worldwide parts profits to the united states, from the moment a part is first designed to when that part reaches a customer, caterpillar u.s. is the engine behind the company's parts business:
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parts design is centered here, with nearly 80% of the research and development dollars used to design caterpillar machines and parts spent in the united states. once designed, caterpillar's replacement parts are manufactured primarily by third party suppliers in the united states, under the supervision of u.s. caterpillar personnel. in 2012, those u.s. suppliers manufactured nearly 70% of the caterpillar replacement parts sold offshore. once the parts are built, the technology, expertise, and management behind a highly efficient distribution system are all here in the united states. parts are distributed through caterpillar's parts logistics operation, which provides caterpillar with o parts logistics operation, which provides caterpillar with one of its key competitive advantages. that operation is managed and run from the united states. caterpillar's inventory management group, located in
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illinois, uses complicated algorithms to forecast parts demand and ensure parts are manufactured in the quantities needed. caterpillar's largest parts warehouse is in morton, illinois, where it stores and coordinates the movement of parts around the world, helping caterpillar's dealer network maintain inventory levels that meet customer demand and delivering even hard-to-find parts within 24 hours of an order anywhere in the world. in short, most of caterpillar's parts executives are here, most of its parts employees are here, most of its parts are designed here, most of its parts are built here, most of its parts are stored here, most of its orders are filled here, and most of its parts are shipped from here. yet most of its international parts profits go to switzerland. in 2012, minutes of the caterpillar board of directors meetings describe the company's parts distribution operations as "u.s.
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centric. " so if the parts business is u.s centric, how do most of the profits end up at caterpillar's wholly owned swiss affiliate? here's how. in 1999, pwc provided the company with a list of 49 potential tax strategies to lower its taxes, including a plan to avoid or defer u.s. taxes on the foreign sales of its parts. the transaction caterpillar adopted was legally complex, but straightforward. caterpillar created a new swiss affiliate called caterpillar sarl, or "csarl. " csarl replaced cosa as caterpillar's leading swiss affiliate, and
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caterpillar gave csarl a license to distribute all of the company's replacement parts outside of the united states. this arrangement changed nothing in the actual operation of the parts business, but caused a massive change in how profits on parts sales were split. because csarl lacks the personnel, infrastructure or expertise to actually run the parts business, it reimburses caterpillar u.s. its costs and a small service fee to continue running the operation. csarl also pays caterpillar u.s. a so-called royalty payment equal to about 15% of the profits on international parts sales, with csarl keeping the other 85%. although caterpillar spent 90 years working to build up its international parts business,
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the license provided caterpillar with no compensation for the assets transferred. that license gives csarl the rights to use caterpillar's patents and trademarks; contracts with suppliers with whom caterpillar had built relationships; proprietary computer systems; and the know-how, methods and data used to manage the parts business. caterpillar u.s. receives only the 15% of future profits from the operation it developed and continues to run. so caterpillar in the u.s. did the lion's share of the work building the business, and does most of the work of operating the business, while caterpillar in switzerland gets 85% of the profit from the most profitable part of caterpillar's business. the law says that transfer pricing agreements between
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related parties must meet an arm's length transaction standard. in an arm's length transaction, no company would turn over a profitable business that took decades to develop without receiving compensation. similarly, in an arm's length transaction, no business would relinquish 85% of ongoing profits in exchange for 15% of the profits. not only did the arrangement change nothing about the actual operation of the parts operation, it also changed nothing on the financial statements caterpillar shows the public and investors. that's because caterpillar and csarl are related companies, with the parent company issuing a consolidated. financial statement. so caterpillar still shows the 85% of the profits sent to csarl as its own profits on the consolidated public financial statement, while telling uncle sam that those profits belong to its swiss affiliate csarl.
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caterpillar has provided several justifications for this change in profit allocation which appear to be inconsistent with the economic reality of its operations. caterpillar claims that the company merely cut out a redundant middleman - caterpillar u.s. and arranged for its third-party suppliers to sell directly to its swiss affiliate. the fact is that caterpillar u.s. is not a redundant middleman in its parts business. caterpillar u.s. continues to play the vital role of managing and leading its non-u.s. parts business the same way it always did. caterpillar u.s. is still designing parts for caterpillar machines, forecasting parts demand, getting the parts built, and storing and shipping the parts to dealers and customers around the world. caterpillar also contends that shifting 85% of the parts profits to csarl made sense,
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because its swiss affiliate provided so-called "intangible marketing" services whose substantial value had not been recognized in the past and deserves the lion's share of profit. but that explanation for sending most of its international parts profits to switzerland is also inconsistent with how caterpillar itself has valued the kind of services that csarl provides. prior to 1999, cosa, csarl's predecessor as caterpillar's swiss affiliate, was one of many marketing companies caterpillar had around the world, each performing essentially the same function of working with caterpillar's foreign dealers to sell and service caterpillar parts and machines. in 1999, as part of the swiss tax strategy, caterpillar consolidated several of those marketing companies into csarl.
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later, in 2001, caterpillar merged into csarl another of its marketing companies called caco, which represented caterpillar with its dealers in latin america, the caribbean, and canada. in connection with the caco merger, pwc, the same firm that designed the csarl transaction, evaluated the intangible marketing assets being transferred from caco to csarl, and concluded that they had little value. in other words, when csarl was the recipient of the marketing intangibles from caco, caterpillar said the value was
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negligible. but when valuing those same intangibles as provided by csarl, caterpillar claimed they were so valuable they justified transferring 85% of its profi that's not all. for many years, caterpillar used an internal profit allocation system it called accountable profits, to help it decide how to award incentive pay, such as bonuses, to employees in its various divisions. beginning in 1992, caterpillar awarded each of its marketing companies an accountable profits share
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totaling about 13% of the parts profits within their regions. but when csarl began receiving 85% or more of profits related to parts, supposedly in recognition of how valuable csarl's functions were, csarl's employees stayed at the 13% profit figure internally when it came to allocating bonuses. in other words, caterpillar again told one thing to uncle sam and another to its employees about the proportionate value of csarl's work. the unreality of caterpillar's current profits split can be illustrated by an example. caterpillar builds a type of mining truck, the 797, shown in this chart, which works in mines around the world, for instance in the alberta tar sands in canada. major components are designed,
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manufactured, and assembled in the united states. the engine is manufactured by caterpillar in indiana; the transmission is manufactured by caterpillar in illinois; the axles are manufactured by caterpillar in north carolina; the tires are manufactured by a third party supplier in south carolina; and the driver's cab is manufactured by a third party supplier in illinois. when those mining trucks are assembled and sold to those mines in alberta, they are exported from the united states, and 100% of the profits from those sales are reported on its u.s. tax return. but when an order for finished replacement parts comes in to service those trucks, even though the parts are manufactured in the united states, stored at a caterpillar u.s. warehouse, and shipped by caterpillar u.s. employees to alberta, the profits on those parts go to
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switzerland. switzerland has nothing to do with those trucks from start to finish. there is no economic basis for allocating those parts profits to switzerland, yet that's where they go. there's more. the unreality of the swiss strategy can also be seen in caterpillar's so-called "virtual inventory system. " caterpillar maintains a second set of parts inventory books solely for tax purposes. csarl has $525 million worth of parts stored here in the united states. none are stored in switzerland. the parts csarl purportedly owns here in the united states are completely commingled with the parts owned by caterpillar u.s. so when a u.s. warehouse employee fills an o rder for a part, that employee has no way of knowing which part is owned by which company. the part is just shipped. after the fact, caterpillar's
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virtual inventory system flags the parts shipped outside of the united states and retroactively marks them as csarl-owned. for hundreds of thousands of parts shipped abroad each year, however, the parts that were shipped actually belonged to caterpillar u.s. when that happens, the virtual inventory system nevertheless shows the part as owned by csarl, indicates it was borrowed from caterpillar u.s. at cost, and later replaces the part when new parts are added to the warehouse inventory. this after-the-fact virtual ownership system is one more sign of how transparent the whole swiss tax strategy is. what is real is the u.s. tax revenue that the swiss
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strategy erases. from 2000 to 2012, caterpillar shipped $8 billion in profits to its swiss affiliate, reducing caterpillar's u.s. tax bill by $2.4 billion. a t bottom, the caterpillar case study centers on a tax strategy purchased by its tax department whose purpose was tax avoidance. it used a licensing agreement that no company would enter into with an unrelated third party. it relied on a virtual inventory system that didn't track of
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parts. it allocated profits for tax purposes that bore no relationship to the profit allocations made for its own business purposes. i am as big a supporter of u.s. manufacturing as you will find. but the caterpillar case study demonstrates that offshore profit shifting is not reserved for those high tech companies that transfer intellectual property to themselves offshore. some manufacturers, too, use offshore tax strategies to avoid paying taxes. the revenue lost to those strategies increases the tax burden on working families, and it reduces our ability to make investments in education and training, research and development, trade promotion, intellectual property protection, infrastructure, national security and more - investments on which caterpillar and other u.s. companies depend for their success. it is long past time to stop offshore profit shifting and start ensuring that profitable u.s. multinationals meet their u.s. tax obligations.
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senator mccain. >> thank you, mr. chairman. after decades of growth, caterpillar has built a global business in which 70 percent of its sales come from overseas. it is my information that at the core of caterpillar's overseas subsidiaries is an independent dealer network that informs the company about local demand and keeps it globally competitive. the majority's report states that many significant functions of caterpillar's overseas parts business are managed and run from the united states. but, in my view at least, two important questions should be asked before that observation can be properly evaluated today - first, what activities are most important in generating caterpillar's overseas sales? and, second, where are those activities conducted?
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"in this case, an important factor in caterpillar's overseas sales seems to be its independent dealer network, which is overseen and managed by caterpillar's subsidiary in switzerland. i understand that this committee has many important questions to ask about how caterpillar chose to structure itself globally. i look forward to hearing from today's witnesses so we will be better informed as to the actual operations of caterpillar and their policy implications. today, the fact is that the united state of america has the highest corporate tax rate of there is no doubt that is a factor in moving operations overseas and, as we have seen from previous hearings, parking those profits overseas rather than bringing them back to be subjected to a 35 percent corporate tax rate. this makes a compelling argument for broader tax reform to ensure our tax code is fair, competitive, and a vehicle for economic growth. i thank chairman levin for his continuing passion on issues
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such as this and look forward to today's hearing. thank you." >> thank you, mccain. i want to thank you. senator johnson? >> let me now call upon our first panel of witnesses. professor bret wells, professor reuven avi-yonah. we appreciate both of you being with us this morning and look forward to your testimony. we appreciate you sharing your
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legal expertise. pursuant to rule six, all witnesses who testify before the subcommittee are required to be sworn. so i would ask you to both stand and raise your right hand. do you swear the testimony you you are about to give will be the truth, the whole truth and nothing but the truth so help you god? we will be using a timing system and one minute before there red light comes on you will see the light change from green to yellow and that will give you an opportunity to conclude your remarks. we will appreciate you limiting your oral testimony to seven minutes. we will have you go first mr. wells. >> very good. i am bret wells and an assistant
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professor of law at the houston law center. i have over 20 years of experience and i have published repeatedly on the topic of international taxation. i would like to thank senator levin and mccain for inviting me to testify. my views don't reflect the university law center or the university of law. i want to make a few opening remarks.
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caterpillar treats their spare parts business and the logistics as a core part. it allows them to deliver spare parts to a customer within the hours around the world thus creating a sales opportunity at the exact moment they can extract margins. the cell of a caterpillar machine creates a future captive market for future replacement sales and their capabilities explain their ability to generate profitability.
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prior to 1999, caterpillar, inc. purchased u.s.-origin spare parts directly from its suppliers. caterpillar, inc. then sold the exported spare parts to a swiss affiliate which then on-sold those parts to the caterpillar foreign dealerships. the profits related to the spare parts business were shared between caterpillar, inc. and its independent dealers. the swiss affiliate earned only profitability of these
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contributed us intangibles, but the subcommittee was provided no evidence that this was done. caterpillar, inc. executed an intercompany agreement to license intangibles related to the spare parts business to provided to the subcommittee indicates that approximately 85% of the profits from the parts business was allocated to csarl5 while less than 15% of the combined profits was allocated to caterpillar, inc. statements from company personnel to the subcommittee staff indicates that nothing changed from a business perspective in the way that the business was operationally run as a result of this tax restructuring exercise. caterpillar, inc. remained the creator and developer of the equipment designs, and caterpillar, inc. maintained operational control over the logistics business related to the spare parts product design, procurement, and inventory management process. during this period, caterpillar, inc. publicly stated that its management of spare parts and its logistical capabilities represented a critical competitive advantage for the company. however, although nothing operationally changed as a result of the 1999 tax restructuring exercise,
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>> the supply chain restructuring implemented by caterpillar is made by a mistake in notion that the profits attributed to the spare parts business system can be allocated away from the functions that generate the profits and assigned to a swiss entity whose functions didn't con tribute to the value or it's development. it is caterpillar inc.and the dealerships that deserve to share the profits. they are attributable to their
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excellent manufacturinmanufactu abilities. no customer contacts and no significant manufacturing int intangible. a court should look through the structuring supply and see ccsal shouldn't be able to do this. current law provides less guidance than it should because section 482 doesn't mandate a specific pricing methodology. so congress needs to make it
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clear it must be justified and allowing residual profits to linger without explanation is a mistake. all of the profits reside in the united states then all of the profits should be obligated to the united states. nothing operationally changed represents a fatal implemntatio is flawed. in my written testimony, i set forth a much more expansive views of why that is so. let me conclude by saying the subcommittee is to be commended
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for taking the time to understand these international shifting processes. they should not end up in a jurisdiction without substance or in an entity that didn't con tribitute to their generation. >> welcome back, professor reuven avi-yonah. >> thank you very much for inviting tee to speak. i will try to make four points briefly. this is, as the subcommittee knows, part of a general phenomenon, there are $2 trillion more or less in profits, that are offshore and out of this a significant portion relates to activities that economically take place in the united states in the form of
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intangibles in this case developing networks. congress has been aware of this and tried several times to legislate in order to prevent the shifting of the profits overseas. in 1992, the bill was intended to predict this shifting and there is a big part addressed specifically to the shifting from the united states to switzerland and the base company rule was designed to address a case in which significant profits from the united states do switzerland using similar strategy to the one used by caterpillar. congress being aware the existing laws didn't work well, enacted the super rule that was mentioned and says that every time you transfer intangible to the united states and the foreign district there has to be a royalty paid. and that was designed to shift a
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lot of profits back to the united states. ... has discovered in its investigation that we have reviewed, that indicates there was no business purposes or transaction other than the shifting of taxable income from the united states to switzerland. in addition it's hard to see what the object tv business
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purposes of the transaction can be in which 85% of profit is shifted from the united states citizen without any actual change taking place on the ground and everything done in the united states just like it has been before. i think that the irs should have a tax on -- it should have also whether there should have been a superroyalty paid and perhaps assignment on income grounds because sale of the parts partsd go the same place the income from the sale of the machine goes. so there's all these opportunities the irs had to go after this transsatisfaction,, - transaction, and didn't. my conclusions? i think the irs should do a
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better job of -- we have the advantages of an expansive investigation. irs should have addressed itself nor this kind of transaction which shifted $8 billion in profits paying $2 billion less in taxes paid, and it's still going on. second of all, i think that congress should address the issue and, i the can simplest way of addressing this is to fix the probably we tried to fix in 1962. at the moment there's an exercise going on, a profit-shifting exercise, under which all of this country, cooler by the g-20, the largest 20 economies of the world, are concern about this kind of profit shifting. number of them have a tax rate below 20%, all have effective tax rate similar to that. there is no competitive
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disadvantage that would result from congress reducing the u.s. tax rate and taxing offshore profits currently. there certainly can be no comparative did advantage in congress taxing $2 trillion because these have already been acouple plated no behavioral insettive or competitive disadvantage would happen. so congress should reduce the corporate rate of -- on a current basis. thank you very much. >> why don't we start with a seven-minute first round and we can have a number of rounds. >> the tax strategy, which we have started to discuss this morning, was proposed, designed, and implemented over several
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years by tax consultants. tax consultants at pwc, working with caterpillar's attend. they paid pwc more than $5 million. is is relevant that the transaction was initiated and driven by tax personnel at caterpillar rather than by business personnel, and involved paying a large amount of money for an explicit tax strategy to lower the company's taxes. is that relevant? professor wells? >> i think it is relevant. i dose think it's dispositive but it is relevant. what is also relevant is the inconsistent stories as it's been implemented, where the taxpayer says a more contemporaneous documents to the time there are no marketing
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intangibles in seesaw. sure, the independent dealers adding a lot of value. they deserve a share of residual profits, but the swiss affiliate is performing nothing but a routine function. they said there was nothing in switzerland that couldn't be easily replicated. it had no significant marketing inning tangibles. earlier transfer pricing reports they said that cat played the largest role in developing the market and dealer development. it was the originate or o the basic marketing do signs. cat was the designer of the systems and the owner of the parts business. all of that comes together as far as credibility of the witness. a judge is going look at this case, and the judge is going to say, where did the economic profits really come from? the person that is testify today
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seems to me making inconsistent statements from everything else that is happening. why did that story come up? why is the story being post lated in front of me? and a judge, trier of fact, is going to look at the overall evidence and they're going to try to determine what are the functions that create residual profits. when the strategy comes from a tax department, and it is divorced from the business itself. then that is a significant fact that a judge is going to look at. when the judge is charged with time to determine what are the economic consequences, where are the economic profits truly being generated. >> if the transaction is designed for the purpose of lowering taxes, that's a relevant fact for the judge? >> should be a relevant fact. it's going to be a combination of facts -- >> one relevant fact. >> that is a relevant fact. >> since 199 caterpillar
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allocated $8 billion in nonu.s. parts sales to switzerland and avoided paying $2.4 billion in u.s. taxes. is that -- is it fair to call that profit shifting? >> i think that is a fair thing to say, given the record that is in front of the committee today. >> about this specific -- bass this specific taxpayer and the functions that generated the $8 billion in profits. >> professor avi-yonah, we codified the doctrine in 20 in saying -- we stated the irs could invalidate transactions that create no meaningful change in the economic position of the taxpayer and have no, quote, substantial purpose other than to achieve a tax effect. start? must there be economic substance in transfer pricing transaction between related parties?
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>> put your mic on. [inaudible] -- >> making sure that you meet both prongs. that is the subject before. some courts have you only needed to meet one. in addition, the irs said that in a true arms-length transaction they will not apply the economic substance. if the transaction makes the standards they won't apply. in my judgment a transaction in which you transfer 100% of the profit in exchange for 15% you're transferring 85% of the profits to a related party and i don't think the arm's length standard applies her and the doctrine can be applied to this transaction. >> now, the caterpillar in its
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written statement says that even if it were stipulated the changes made in 1999 were motivated primarily by tax considerations, and generated primarily tax effects, in the economic substance doctrine would still not apply do. do company you agree we dock transcribe would not apply if the changes in 1999 were motivated primarily by tax considerations and generated primarily tax effects, and the transaction did not meet the, quote, arm's length standard, which is a transaction that wouldn't be made with an unrelated third party. >> i think in this case economic substance doctrine would apply. >> professor wells, is it true the law requires in every case that transfer pricing agreement must meet the arm's length standard? it must be a transaction that caterpillar would enter would if one unrelated party? >> that's exactly right. in fact current law makes its clear that even if there are
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multiple transfer pricing methodologies you must choose the best method, and the best method under existing treasury regulations, is the one that is the most reliable and putting the profits in the functions that generated those profits. so, even if we have a debate between one method or a different method, court is going to ask the question, what would an arm's length party have done? >> and would a -- any reasonable business have entered into the type of exchange that occurred here? >> no. because what occurred here was a failure to recognize that we -- there was a captive spare parts market. if we used the words of caterpillar, seed, grow, harvest, when they're talking to the stock analysts how to value their company, they said when we sell the caterpillar machine, it is like seed and growing and the harvesting is the spare parts
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which we get to do once that machine breaks down. and nobody would let someone come in at harvest time after the crop has been to seed and grown and ready to harvest. nobody except a related party that doesn't care about the profit shifting. >> do you agree with that, professor? >> yes. >> thank you. center mccain. >> thank you, mr. chairman, and thank the witnesses to the witnesses, this restructuring took place, it's my understanding in 1999? and yet no case has been brought against them by the government for what you view is a clear violation of law? do you have an explanation for that? >> i think it's partly because some of the information that was provided to the subcommittee would not have been available to the irs.
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related to internal tax planning documents that are privileged. that is not obvious on its face from the outside. in addition, some of the information was based on the whistleblower and also was not available to the irs at the time. it was a senior tax person inside the company. so we today have much more information about the transaction than was available to the irs. in my opinion the irs is overburdened and had too many companies. here's transactions are very complicated. extensively documented. the irs has to go through thousands of pages of data, they just have a hard job to do. i think they should have done a better job in this particular case. >> so, the irs looked at this restructuring, reached a conclusion that was a failure of
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the irs to gather all the sufficient information or didn't hear from a whistleblower, wouldn't that be reason for the irs to re-open the case? >> i suspect by the time the whistleblower case became public, these have been closed already in the -- >> well, nothing prevents them from re-opening it. >> if the year is closed, the statute of limitation has run, they cannot -- >> they're operating today under a scheme that you view as illegal. since when does the statute of limitations affect that? >> no. if -- i mean there are two arguments here. there's the economic substance argument that relies to the original transaction. the original transsection is closed and they cannot go after that. there are other arguments. a question whether there should be a superroyalty, and the question of whether there was an
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assignment of income. all those theories are still available to ther is and is i encourage the irs to closely examine what is going on now between the company and csarl and see if they cannot criticize them own those theories injury did you have additional comment, professor? >> i think it's an important public service to show the irs in hearings like this the result of a thorough investigation of a factual record like this. at a time when companies are concerned and taxpayers are concerned about bay's -- bay's rogues and profit shifting. one thing i hope the senate can agree on, whatever reforms need to be made, we need to make sure the transfer pricing rules allow the taxpayers and the government to be confident that the taxes that are economic -- the profits that are economically earned in the united states, will be paid
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in -- taxes will be paid on those profits there may be other reform measures that the senate may not be able to agree on. but i think it's an important public service whenever the profiles like this, where a spare parts annuity exists internally, and the profits are shifted, and that has not been dealt with on audit. i think congress needs to think about what reforms need to be done, and i think the irs needs to think about what do we need to do better to do a better job of getting the facts in a detailed way like this committee has done. >> so, when there is something this egregious going on it requires a congressional hearing to get the irs to carry out their responsibilities. it's my information that the irs received an anonymous letter with allegations in 2004, five
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years after the restructuring, looked into it, and brought no charges. so, that american people and -- i don't have a lot of confidence in the irs but now we have less. let me -- i think that's important point. >> i think it's hard to come up with good legislative reforms, senator mccain, if we don't have detailed case studies like this. congress needs to develop legislation in light of the current reality, not divorced from the current reality. i think that's an important point. >> professor, i think you would agree there's at least -- aim correct, a trillion and a half dollars parked overassess at this time? >> my knowledge is from publicly available information but that's consistent with what i've read in the public. >> some years ago we did kind
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of -- whatever you call -- repate treation in the hopes -- that would makemer jobs boost our economy, and basically it went to pay salaries and stockholders. >> that's a fair characterization of the empirical data. >> so any reform we make in order to -- or steps we may take no order to repate trait some of this money, perhaps we should have requirements for job creation and how -- isn't the larger estimate if you're going to bring money home and pay 35% corporate tax, is which the high highest in the world, you're
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going to try to find ways to not pay taxes on it legally. or in a gray area, or in violation of at least the spirit if not the letter of the law. so, if you had a recommendation to congress to address this issue and prevent future -- no heart you feel about this case or not -- what would you recommend that congress do to try to make sure there is adequate taxation and a disincentive for this kind of activity that this committee has investigated on numerous cases. could both of you give us a response? >> if we got the corporate tax rates to 20 to 25%, we could apply to all of the overseas profits of u.s. multinationals without putting them at
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significant disadvantage -- >> could i interrupt. that would be sufficient incentive, you think, for them to bring that home, a 20% rate roughly? >> i think so. yes. >> thank you very much, professor. >> thank you. >> my main point is, when we talk about repatriation tax rates and whatever, think the public may have a different point of view, senator mccain, whether or not the profits are u.s. origin profits that have ma trick lated away some are sorting back or their really profits functionally created and related to activities that occur outside of the u.s. before you look at any reform, 482 needs to be absolutely clear that you can't just designate an entrepreneur to just take the profits of an internal multinational. we need to have rules that say that the profits are going to be scored in the right jurisdiction
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economically first, and then what we do with foreign income after that would be a next question. i don't think that the public would be excited or happy about having profits end up as foreign income that are truly u.s. origin profits and get a different tax rate than what the general american has to pay or the taxes they really are having to pay based on the wages in the u.s. i think 482 is a first place we need to make very sure is protected. >> thank you. thank you, mr. chairman. >> thank you, senator mccain. senator johnson. >> thank you, mr. chairman. professor recalls, my information is cater pillar claims 77% of profits overseas. is that accurate. >> sounds accurate. >> transfer pricing allocation of profits is complex process. correct? >> um, not when you get the facts in front of you.
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when you get the question of excessive profitablity related to spare parts you have to go through a complicated question or factually determining -- >> i got that from your testimony. let me -- you've done an awful lot of practicing in tax law with large multinational corporations, i imagine. talk to me a little bit about about how the irs works with a large multinational company like caterpillar? what's that relationship like? >> that's likely to be a better question for your next panelist. i have no specific information on how the caterpillar audit works. >> my understanding is caterpillar has 12 full-time irs agents working on their -- sound reasonable to you? >> could be. that sounds reasonable and consistent with me experience. >> if you have no matter what the numbers, if you have full-time irs agents -- that's
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me experience as well -- looking at your tax returns, pouring over it, talking to tax managers in that business about how they're working to comply with the laws, that's a pretty ongoing monitoring and ongoing thorough investigation of the tax situation. >> but generally the process that an audit level is through an information disclosure request, an idr, question is asked and answered. subpoena power is very little used in an irs, like in this commitee. when you ask for all documents, i want to know what are the relevant documents other than just the specific statement you want me to know. that is often times not given over to the irs. and so when cases go to trial or get docketed for trial there may bell we a complete set of documents handed over, but the irs typically will just be asking questions and will not be given all of the responsive documents or the e-mails or
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internal documents or the internal -- >> my experience with the irs, they're pretty detailed and they ask a lot of pretty good questions and require you provide an awful lot of documentation on how you fill out your tax return and how you report income. let's assume that congress can address the situation and write a law to address what caterpillar is doing here. with 70% of caterpillar sales going overseas whoa could caterpillar do functionally to make sure that even if we change the law the economically earned profits are actually earned overseas so they can take advantages of lowering tax jurisdictions than in the united states. >> that's an excellent question. >> they can move operations overseas, couldn't they? they can start manufacturing overseas. >> yes. >> if we do this, would be exactly what large corporations like caterpillar would do, stop
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manufacturing in the u.s. and then start manufacturing overseas so they're matching their economic activity with their actual sales overseas. >> well, it's -- >> how would that benefit the u.s.? >> if what you're asking is we want taxpayers to report their taxes consistent with the economic truth, then that is a good -- a worthy goal. if congress wants to promote in sub dis and some other way, then that's fine. what we should not have is having average americans report on their tax return taxes they economically believe are do hugh but sew fess tick indicated taxpayers through -- sophisticated -- >> through laws that manufacturers stay here and provide jobs here and import overseas. so they're manufacturing here,
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exporting overseas, we'll due a thorough investigation, as opposed to having this adjudicated in the tax court with tax law, we're going to hold a trial here against a company that is manufacturing and exporting, which is what every here, all these politicians in washington want us to do. does that sound just a little crazy to you? >> does not sound crazy to me if what your goal is to know what the current reality is so that your laws for the nation actually describe the truth. >> so we can -- we can change that law, we can change that reality, and then manufacturers -- then companies like caterpillar will start manufacturing overseas. does that make any sense? >> i do not believe -- i believe that caterpillar, if they're benefiting from the u.s. economy, should pay their fair share -- >> they're paying 29% of their profit, are they not? >> -- and allocating profits to a subsidiary that did not
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economically perform those functions or create the residual profits is an inappropriate answer. >> so, it is true the cat pill already pays an effective tax rate of 29%. correct and. >> that's correct. >> in multinationals that a pretty high effective tax rate. correct? >> depending on who you're benchmarking against, but if all of the functions that are -- that create the residual profits are in the united states, then i think it's not a high tax rate under current law. if what you're asking me, senator johnson, should we reduce the corporation frat tax rate from 35 to 25? i think that's a fine suggestion. but whatever the tax rate is, we shouldn't just say -- >> i guess -- >> get the rate down -- >> yao talked about fair share and when you have a multinational paying 29% effective rate, that's generally real -- e that's a pret where high effective tax rate. i would be talking to my tax manager and saying what are you
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doing wrong sneer let me quickly ask the differentiation between tax avoidance and tax evasion. >> tax evasion is illegal and tax avoidance is legal. neither of us would say that what was done here was tax evasion. this was tax avoidance, but the question is whether it complies with the law -- >> i think you both said nat what caterpillar was doing was probably illegal, and the irs should challenge it. >> i think that the irs should challenge it and i think to the court would hold it violated the economic substance doctrine which would till -- >> that's my final point. if caterpillar is doing something wrong the proper venue would be a court of law, tax court, and have the irs adjudicate this thing, not congress. thank you. >> thank you, senator johnson. let's have a second round. professor wells, i think your
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main point here is that if caterpillar has 54 manufacturing facilities here and it's economic functions are prince my carried out here they shouldn't pretend it's in situaterland. >> that's exactly right. we should say you can't just nominate a swiss tax entrepreneur. the residual profits, if it's billions of dollars, and there's only a couple of million dollars in snga costs in that entity, if it's far in excess of what function it's actually performing, that is problematic. >> you have made reference to what you call cieko. maybe the caterpillar folks can give us the correct way to announce -- pronounce that acronym in 1999, caterpillar
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hired pricewaterhouse to review its business operations to reduce its taxes. and they at that time claimed that it identified that the csarl had certain marketing intangibles that were so valuable they justified dramatically increasing the portion of nonu.s. parts profits sent to switzerland and you discussed that is not the case in your judgment. we have been -- i've indicated that in my judgment, and i think our report makes it clear, that your judgment is indeed the correct one. here's my question. in 2001, caterpillar decided to transfer the same type of marketing intangibles from cieko to csarl.
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and then pricewaterhouse found those same marketing inning tangibles had little value. and here's what they said in 2001 relative to the now -- the same type of transfer. they describe the intangibles, being transferred, now to csarl from cieko, existing dealers, training programs, order tracking software developed by caterpillar u.s., written sets of procedures and manuals which were originally developed by caterpillar u.s.. marketing prosures and a web site, both which were developed by caterpillar u.s., any other marketing -- such as good will and going concern. they found that particular marketing company, doing the same marketing as csarl, dealing
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with the dealers, they found that those csarl-like marketing intangibles were routine. have you seen the exhibit? >> yes. i have it in front of me. >> i think it's exhibit number 13. is that correct? >> yes, it is exhibit 13. >> all right. now, they also said that these intangibles are common in marketing companies, only have limited economic life, easily reproduced and have little or no value on a stand-alone basis. are those positions reconcilable? >> no, they are not. and pwc, i think in a subsequent e-mail, union page 92 of your
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report, they tell you after the fact it's not reconcilable. they say caveat in 2001 we said in another transaction there's no significant marketing inning takables. so even after they were maintaining that marketing i inning tangibles were found, they recognized that making that argue wax inconsistent and continues to be inconsistent with the cieko transaction, and what i want to make sure that you and nor mccain understand, if that cieko transaction -- 367d gives a continuing, ongoing obligation, every year for the next 20 years after that transaction, to true it up. >> there's another issue which has been referred to briefly but i want to go into it. that has to do with what was done from 1992 to 1998, which
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was to assign a routine profit to the divisions that performed routine business services and to assign the larger residual profit called the entrepreneurial profit, to the divisions that contributed directly to the creation of those residual profits. according to cat till pilular -- caterpillar's internal management books they treated cat pill already razz predecessor as a routine parts producer and gift a routine share of the profits in the range of 15%. that's before this transaction. now after the traps satisfaction, after the csarl transaction, caterpillar maintained the same practice. on their internal management books, to determine bonuses, csarl continue to receive credit only for the type of routine
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profits allocated to parts distributor, about 15%. so, when it comes to paying income tax, caterpillar reports to uncle sam that csarl received 85% of the profits for the parts business. when it comes to bonuses, internal financial practices, that was not the case. now, let me ask you both, is the fact that the accountable profits for bonus purposes did not change, affect -- would affect, guess, anybody, as to which caterpillar business functions created value and profit in the nonu.s. parts business? >> that's the most important indicator because that's what shows internally what the company -- i think the irs should look at these kind of compensation-related factors as very important way to measure what the true profit assignable
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to each company. >> professor welts? >> yes. we're get though same question, senator levin, and a court will use a number of data opinions to determine what are the real functions and what will it take for -- what contribution of those functions to the overall profits? and nat would be another important data point. >> my time is up. >> let me -- one of the common reasonses that is offered for shifting profits under a licensing agreement to an offshore subsidiary in a tax haven, is a claim by the u.s. parent that it also shifted the business risks to its offshore
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affiliate. the u.s. parent asserts -- could assert that because the risk has been transferred, that the offshore affiliate is entitled to the lionies share of the business profits. here using that line of reasoning, caterpillar has claimed that csarl now has the risk for the parts business because it, quote, owns the inventory. but caterpillar also issues a consolidated financial statement that includes all of csarls financial results, which seems to me to indicate that caterpillar retains the risk for the business. if something happens to that inventory caterpillar bears the risk, not just csarl. so let me ask you both for your analysis on this point. was the business risk really transferred to csarl? professor? >> i don't think you can transfer this kind of business risk. the risk to the parts business is the risk to the overall
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caterpillar business. they build machines that only take these parts. to the extent there's a risk to the parts business, it's a risk to the machineses business, which is centered in caterpillar u.s. so there's no specific risk here that can be transferred. it's not like a situation where you are developing an intangible and the research may succeed or not succeed and you're putting that risk offshore. in this case there was in risk independent of the risk for the entire business and that is in the u.s. >> senator levin, they shifted the risk until they didn't. you remember the virtual inventory in your opening statement. all we want to claim that one company is the sole owner except when the part is needed somewhere else, and then it's assigned over back and forth over ten percent of the parts shipped seamlessly back and forth. so the course and conduct of the parties would be necessary to look through. but that's -- so i think i would answer you in two parts.
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one, when you say, i have the risk of the parts, but the parts are managed and controlled by caterpillar, inc., and whenever caterpillar inc., wants to use the part for any other purpose, they can, and it's seamlessly shifts back and forth, think it takes away that defined, immediate ownership, point number one. second point i would argue is that even if there is a routine profit for being an entrepreneur, the value here has nothing to do with that entrepreneur function. has to do with the business system. has to do with what the independent dealers created, the logistics capability, the manufacturing, and that these spare parts are specially designed to work in equipment and are being sold and can get to that customer at a moment when there is an urgent need by the customer to pay for those parts. it's that business system that
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was created by caterpillar, inc. that is the intangible that needs to be valued. so, if csarl deserves some entrepreneur profit for speculating in spare parts, strip out the proprietary aspect, strip out the residual profits related to the sophisticated logistical enterprise and algorithms and everything else. strip out the profits of those to the functions that create those aspects of the value, and when you do, you'll find there's very little left for csarl other than what pricewaterhouse said in their cieko report, there's nothing other than a routine function. that cieko performs compared to everything else building the mousetrap. >> the val you've over the cieko
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transfer was treated the same as was transferred to csarl, or -- excuse me -- what csarls intangibles are or were, as claimed by pricewaterhouse, doesn't that create a huge tax liability? in other words, if they were treated the same way, thei eeko transfer in terms of intangibles, don't you have a situation then where you got an ongoing tax liability for cieko and that means for america? >> yes, that's true. and the point that congress dealt with when they enacted section 367d, is that if marketing intangibles do leave the u.s. taxpayer, the u.s. taxpayer needs to be paid a royalty commence rat with the income created from that marketing intangible. so as on the company says that we have found this newly discovered value, then the royalty would have to be
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upticked by a commence sure rat amount. >> let me state the question more clearly. they're analysis of the value of those intangibles carried the day, when they discovered those intangibles in csarl, well, now when cieko transferred those same intangible and if the same valuation method is used, that would be a major transfer, would it not? >> it would. >> then would that not have a ongoing tax impact to caterpillar because cie cois in the united states? >> that's true and what is also trues -- we would also have to ask the question, these newly discovered intangibles, did they come from a u.s. company in another transaction? third they ma trick -- move to
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csarl. >> do you agree with that? >> yes. >> my last questions. has to 2005pwc proposed, designed and implemented the tax strange that led to the formation we just described. now, at the same time pricewaterhouse performs two functions, in other words, it's caterpillar's independent audit for, and also it's tax consultant. advising on swiss tax strategy. so one of the auditors -- by the way, one of the auditors responsible for advising on tax issues, on the audit, at the same time spent bat third of his time working with his tax consultant colleagues on the swiss tax strategy. so, during this several, year
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period, caterpillar paid pwcs tax consulting service over $80 million, including more than 55 million for the caterpillar swiss tax strategy, and wcs auditing service more than $200 million. when an independent audit for approves a tax strange promolessed by its own colleagues it creates an appearance of conflict of interest. i want to be clear that sarbanes-oxley permits an accounting firm to provide tax consulting service while acting as a company's audit forker -- auditor if the company's beside board of directors gives approval. and i want to be clear the caterpillar board board provided that approval. so no suggestion here there's any violation of sarbanes-oxley.
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that's not my question. the question is, should that be allowed? because i think that's something we can perhaps get some expert testimony on from you on this, should a board of directors approve this kind of arrangement? they did and we're not challenging that -- i'm not suggesting a violation of sarbanes-oxley, because they did approve it. i just want to spend one minute before we turn to our next panel on this subject. this goes to whether or not we should change the law in this regard. >> i think we should. i don't think it should be allowed. think there's an inherent appears on of conflict of interest when the independence odd odd it for is making the new strategy, and the rules there has to be an opinion that the distract is more likely than not to succeed in order to take a reserve on its financials and when it's the same person doing
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that, of course you would reach that level more easily rather than an independent person. so we should change the law to make this kind of situation impossible. >> i don't disagree with that but die want to say under current law, think that pricewaterhouse and caterpillar, from what i've seen, did everything they need to appropriately inform the board to get permission. i want to made clear -- >> i made it near my question. >> and i want to make it clear in my response under current law there was any ethical or legal violation of sarbanes-oxley. i think that looking at having more silos between the person that is proposing tax strategies and the independent auditor is something that needs to be reformed. >> i think it was clear we were not suggesting otherwise.
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we had a picture of there of a mining truck, where the parts profits go to switzerland but that's about the only thing that switzerland related to, was the profits. there was no manufacturer of anything other than united states and it was sold in canada and to -- mining equipment. so the question is whether or not you can assign income that way? there is not a judicial doctrine that prohibits an inequitable distribution of profits that results from a taxpayer separating the fruit -- the income, as i think professor wells talked about. from the tree on which it grew. can you explain how than assignment of income doctrine
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might apply to the facts in this case study? >> so, if you think of the sale of the part as something that is inexorably related to the sale of the machine the parts fit into -- this the way that both the company and pricewaterhousecoopers described it, both in the board constitutions, it's an annuity that flows out of the sale of the machine and the seed grow harvest model professor wells alluded to in the pwc transfer. the parts are always linked to the sale of the machines. if that's the case, then i think the irs can make a good argument and a court may well accept an argument that the profit from the sale of the parts is linked to the profit of the sale of machines and the sale of the machines -- the machines continued to be made in the united states and exported from the united states, the profits on the sale of the parts should go with the machine, including the n the case of the mining trust. >> professor, do you have anything more teed on that? >> other than i agree with --
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say that the professor said. >> thank you. you're excused. we move tower second panel. [inaudible conversations] conversation >> we'll now call or second panel of witnesses for today's hearing. tom ms. f. gwynn, tax partner as pricewater housecoopers in chicago, steven williams, a manager director at pricewaterhousecoopers, and we appreciate you being with us today. we look forward to your testimony, and i think as you heard pursuant to rule 6 all witnesses who testify are
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required to be sworn. i ask you to stand and raise your right hand. do you swear the testimony you're about to give before the subcommittee will be the truth, the whole truth and nothing but the truth show help you god? thank you. >> we'll be using the timing system today which means that about a minute before the red light comes on, you'll see a lying change from green to yellow, give you an opportunity to conclude your remarks. your written testimony, of course, we presented in the record in its entirety and we'll ask that your oral testimony be ten minutes or less, and we understand mr. quinn you're going to present the pricewaterhousecoopers testimony. your mic is not on. >> thank you. good morning, chairman levin,
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ranking member mccain, and members of the subcommittee, i'm going to make some brief oral remarks but ask my written statement be placed in the record. >> it will. >> i am thomas quinn, cpa and partner at pricewaterhouse coopers. i ban any career with pcw in 1948 and have been advising companies for over 30 years. i'm joined by james bowers, also a cpa and partner in the pwc tax practice. having joined pwc in 1976, mr. bower has been advising clients with respect to tax obligations for over 37 years. i'm also joined by steven williams, managing director with pwc. mr. williams is an economy exist holds a masters degree with concentration in international economics. he has been we pwc since 1982 and specializes the transfer pricing for 28 years. understand
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that today's hearing relates to the tax implications of a business reorganization that caterpillar gap 15 years ago. i was one of the pwc partners who provided advice in connection with the matter. mr. bowers is a tax partner who assisted the audit team with the audit of the tax aspects of caterpillar's national statements, and mr. williams provided caterpillar with assistance regarding transfer pricing rules. at the outset, let me say on behalf of pwc, we recognize both the long-standing interest of this subcommittee in corporate tax issues and the importance of those issues. in that spirit, pwc has cooperated fully with the subcommittee throughout this inquire and has willingly accepted your invitation to testify this morning. addressing our engagement with caterpillar, lay lou mr. to provide an overview of our tax practice. pwc is the leading provider of
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tax services world wilde in terms of size and scope of our tax practice, and we believe in terms of our reputation. we strive to combine our specialized tax knowledge in national and local jurisdictions, with a deep understanding of our client's business and economic environments, in order to assist them with their tax compliance obligations across the globe. in working with multi national businesses, we routinely eval at it issues of international taxation which can be particularly complex. caterpillar is one of the world's largest manufacturerrers of construction mining equipment, diesel and natural gas engines and industrial gas turbines. cat pill they sale more than 300 types of items on six continences. cat pail already and its subsidiary sells machines and replaces parts for the machine. machine sales lead to part sales
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and part sales support can and encourage machine sales. there is no separate parts business. it is an integrated activity organized around caterpillar's product groups, and it is designed to maximize both value to its customers and caterpillar's profitablity. demand for replacement parts derived from the independent dealer network and the field population of machines. that demand is then fulfilled through its logistics organization. caterpillar's business haps has been expanding throughout the world to meet increasing global demand. the late 1990s sale outside the united states accounted for more than 50% of consolidated sales. today more than 65% of sales are outside of the united states. to meet they demand caterpillar established subsidiaries outside of the united states to market its products products and provit support abroad. caterpillar has expanded
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subsidiary manufacturing facilities worldwide to meet global demand for its products. today the caterpillar group manufactures products in more than 20 countries. in short, indicate pillar has transformed itself from u.s.a.-based manufacturer of machines and parts for sale to u.s. dealers, into a global manufacturer of products and parts for dealers around the world. in 1998, as the globalization of caterpillar's business continued to evolve. caterpillar ingaged mcdermott and pwc to advise the company with respect to international task position. to develop our advice pwc tax professionals first gauged in an extensive study of indicate pill already razz organization and global operating footprint, spending considerable time at caterpillar's operating facilities all over the world. we observe third business organization as it existed in 1998 failed to capture the evolution of the true economics of the business.
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and subjected the current to current u.s. income taxation, income earned from the sale of products to foreign customers, largely as a result of the subpart f rules. working with caterpillar's operation's group its tax department and mcdetermine mat, we analyzed alternatives that would better align the true economics of the business with caterpillar's operations and positively affect its global effective income tax rate. after reviewing the information provided by mcdermott and pwc, and in light of the evolution of the global operating footprint, caterpillar decided to undertake a significant reorganization of its foreign operations. considering the growth of its foreign operations, cat pill already ender it made sense to centralize in one company the manufacture and distribution of products outside of the united states. through caterpillar overseas, caterpillar already had a stinct
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shall business presence in switzerland with hundreds of person nell behlesed in a multistory facility in geneva, including a number of key corporate executives inch 1999 cat pill larry transferred assets to csarl, company bailed in switzerland. that company took over operations across the globe to handle sales of machines and parts outside of the united states. caterpillar inc. continued to handle sales of parts and machines in the u.s. from its outset, caterpillar csarl carried the risks and profits and losses from being the owner and seller of the machines and purchased finished replace emt parts in international markets. caterpillar purchase parts directly from third party supplies and sold finished products to third party dealers. because of the sales no longer involved the related party
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transaction between cat pill splash its foreign affiliates or between foreign affiliates themselves they were subject to the fundamental u.s. tax rule that foreign business income is not taxed until they income is remitted to caterpillar in the united states. the reorganization culminated in changes to roles and responsibilities, at significant and economic and legal effects and resulted in significant tax savings. after the global business reorganization, caterpillar inc.'s role included acting as a service provider for certain purchases method by caterpillar in exchange for a service fee. caterpillar licensed its rights to caterpillar csarl to make machines to purchase and distribute replacement parts and to use caterpillar technology and trademark on the products for sale outside the united states, in exchange for a license fee. because cat pill splash caterpillar csarl were related
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companies these payments were subject to irs transfer pricing rules. pwc tested the prices annually, not only under the best method as required by u.s. law but also enough each of the other relevant transfer pricing methods prescribed by the treasury regulations. each analysis supported the arms length nate tour of cat pillar's related party pricing in addition to providing tax services pwc has been auditing cat pail already's statements for many years. we have been asked to -- the independent rules. the delivery of task consulting services to audit clients has long been permitted by the rules of the sec, the pcaob, and the aicpa. pwc venezuela tax and odd kit services to caterpillar complied give this standards. they assess independence on quarterly and yearly and disclose to caterpillar's odd
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did committee any relation happy to that bore on on newspapers. pwc venezuela provision of tax self-s to caterpillar as an audit client was appropriate. chairman levin and members of the sub committee, thank you for this opportunity to testify about pwcs tax services with respect to caterpillar. we firmly believe then and firmly believe today that the tax services we provided and the positions caterpillar tack in that regard complied with the law and were entirely appropriate. likewise, we believe that our tax and auditing engagement satisfied the letter and the spirit of the independence rules that govern our practice. we'd be happy to answer any questions you may have. ...
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for you or the people in the company's tax department. is that correct? >> in part that's true. we also had significasignifica nt contact with individuals in the operations department of caterpillar. it was dependent very much on the understanding of the operations in the business and contact with them is critical. >> now prior to the tax consulti


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